Definition
Negotiated Transfer Prices are prices used for transactions of goods or services exchanged between divisions within the same organization that are set through negotiations. These prices are often adopted when there are imperfections in the external market that prevent the determination of a fair transfer price or when standard pricing mechanisms fail to reflect the true economic value of intra-organizational transfers.
Examples
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Example 1: Technology Production Division
The technology production division of a corporation manufactures specialized components. The marketing and sales division needs these components for product assembly. Given the absence of a robust external market for these specialized components, both divisions negotiate a transfer price, considering production costs and estimated market potential to settle on terms beneficial for both.
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Example 2: Food and Beverage Corporation
In a large food and beverage corporation, the beverage manufacturing unit produces a unique ingredient used exclusively by the dessert division in their product line. With limited external benchmarks, the two divisions negotiate a transfer price that approximates the ingredient’s value, factoring in production costs and desired profit margins.
Frequently Asked Questions
Q1: What factors influence the negotiated transfer price?
- A1: Factors include production costs, market conditions, desired profit margins, dependency of the receiving division, relative bargaining power, and potential use of a mediator.
Q2: Why use negotiated transfer prices?
- A2: Negotiated transfer prices are used to ensure fairness and maintain harmony between divisions when market conditions are imperfect or non-existent, thus reducing potential conflicts.
Q3: Can negotiated transfer prices affect tax liability?
- A3: Yes, the prices may affect the overall tax liability of the organization, especially in multi-national companies operating in different tax jurisdictions.
Q4: How is bargaining power relevant in transfer price negotiation?
- A4: The relative bargaining power determines how much leverage each division has in the negotiation process, often influencing the final agreed-upon transfer price.
Q5: Are there alternatives to negotiated transfer prices?
- A5: Yes, other methods include market-based transfer prices, cost-based transfer prices, and adjusted market prices.
Transfer Pricing
The practice of setting prices for transactions between controlled or related legal entities within an enterprise.
Market-based Transfer Pricing
Transfer prices set based on prevailing external market rates for similar goods or services.
Cost-based Transfer Pricing
Setting transfer prices based solely on the cost of producing the good or service, either at full cost or variable cost.
Bargaining Power
The relative power of parties involved in a negotiation, influencing the outcomes based on their relative strengths and dependencies.
Mediators
Neutral third parties that help resolve disputes or facilitate negotiations between divisions or parties.
Online Resources
- Investopedia: Transfer Price
- Corporate Finance Institute: Transfer Pricing
- OECD: Transfer Pricing Guidelines
Suggested Books for Further Studies
- “Transfer Pricing Methods: An Applications Guide” by Robert Feinschreiber
- “Transfer Pricing and Corporate Taxation: Problems, Practical Implications, and Proposed Solutions” by Elizabeth King
- “International Taxation and the Extractive Industries” by Philip Daniel
Accounting Basics: “Negotiated Transfer Prices” Fundamentals Quiz
### What is a negotiated transfer price?
- [ ] A price dictated by external market conditions.
- [x] A price set by negotiation between internal divisions.
- [ ] A price based on government regulations.
- [ ] A cost-free exchange between divisions.
> **Explanation:** A negotiated transfer price is set through internal negotiations between the supplying and receiving divisions within an organization.
### When are negotiated transfer prices typically used?
- [ ] When external markets provide clear pricing signals.
- [x] When there is an imperfect market for the goods and services involved.
- [ ] When governmental policies mandate fixed prices.
- [ ] When external audits demand it.
> **Explanation:** Negotiated transfer prices are particularly useful when market imperfections exist or clear external pricing is unavailable.
### What factor significantly influences the agreed negotiated transfer price?
- [x] Relative bargaining power of the divisions.
- [ ] Physical size of the company.
- [ ] Historical transfer pricing data.
- [ ] Number of products transferred.
> **Explanation:** The relative bargaining power of each division can significantly influence the outcome of the negotiated transfer price.
### What role can mediators play in setting negotiated transfer prices?
- [ ] Mediators enforce the final price.
- [x] Mediators assist in facilitating the negotiations to reduce conflicts.
- [ ] Mediators set external market benchmarks.
- [ ] Mediators develop the product specifications.
> **Explanation:** Mediators can be used to help ease negotiations and reduce conflicts between internal divisions.
### Why is it important to set a fair negotiated transfer price?
- [ ] To ensure inflated profits for the supplying division.
- [ ] To comply with environmental regulations.
- [x] To maintain harmony and reduce disputes between divisions.
- [ ] To increase external customer satisfaction.
> **Explanation:** Setting a fair negotiated transfer price maintains harmony and reduces potential disputes between the supplying and receiving divisions.
### Which method could be an alternative to negotiated transfer prices?
- [x] Market-based transfer pricing.
- [ ] Historical cost averaging.
- [ ] Price skimming.
- [ ] Transfer-free trading.
> **Explanation:** Alternative methods include market-based transfer pricing, where prices are set based on external market conditions.
### How do negotiated transfer prices impact tax liability?
- [ ] They eliminate tax liabilities for the divisions.
- [x] They influence the allocation of taxable income between divisions.
- [ ] They consolidate tax obligations company-wide.
- [ ] They standardize tax rates across the organization.
> **Explanation:** Negotiated transfer prices affect how taxable income is allocated between the divisions, potentially impacting the overall tax liability.
### What aspect is often considered when using cost-based methods as opposed to negotiated transfer prices?
- [ ] Marketing expenses.
- [ ] Depreciation schedules.
- [x] Production costs.
- [ ] External consultant fees.
> **Explanation:** Cost-based methods focus on the production costs of the internal good or service.
### Can slightly different negotiated transfer prices be beneficial for divisions within a company?
- [x] Yes, they can help divisions achieve divisional goals while considering overall company performance.
- [ ] No, it creates accounting complexities.
- [ ] Yes, if it consistently increases revenue for one division.
- [ ] No, only standardized prices should be used for consistency.
> **Explanation:** Different negotiated transfer prices can be designed to meet specific goals of the divisions while sustaining overall company performance.
### What key benefit do negotiated transfer prices offer over other pricing methods?
- [ ] Increased revenue from market sales.
- [ ] Decreased costs of production.
- [x] Flexibility to address specific divisional needs and reduce conflicts.
- [ ] Uniformity in transaction reporting.
> **Explanation:** Negotiated transfer prices bring the flexibility needed to address the specific needs of divisions and help reduce internal conflicts through mutually agreeable terms.
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